Daily Gains Letter

One of the Best Ways to Create Wealth: Dividend Reinvestment

By for Daily Gains Letter |

Dividend ReinvestmentRight now we have a stock market that isn’t doing anything. Earnings outlooks are modest and so are investor expectations for capital gains. In fact, 2013 is shaping up to be a tough year for stocks and return on investment is likely to be very modest. This is why dividend income is so crucial to your savings and financial planning.

For our beginner investors, a dividend is the payment that a company distributes to its shareholders as a percent of earnings. Management can decide whether to pay a dividend, how much it is, and the frequency of payments. Dividends are often distributed quarterly and are quoted as the amount of dividend per share. Companies that are growing fast tend not to issue a dividend, as they pour money back into the business.

Investing in the stock market isn’t for everyone, but one of the ways you can grow your wealth over time is to own higher dividend paying stocks, and reinvest those dividends into new shares. If you don’t need the income because you’re saving, dividend reinvestment is one of the best stock market investment strategies you can employ. More shares equal more dividends and your actual stock market returns begin to compound quicker than you think.

Consider, for example, a company like PepsiCo, Inc. (NYSE/PEP), which is stock with a long-term track record of wealth creation and rising dividends for stockholders. According to its history on the stock market, PepsiCo looks to have been a good buy every time it experienced a major pullback in its share price. The company’s recent stock chart is featured below:


Chart courtesy of www.StockCharts.com

So, say you invested $10,000 in PepsiCo in August 2009. Back then, the stock was trading for around $57.00 a share. Now the position is trading around $70.00 a share, for a simple return of approximately 23%. But this return on investment doesn’t include the dividends earned during this period of time and, if you were to take those dividends and reinvest them in new shares of the company (PepsiCo has a full and partial dividend reinvestment program), your returns are a lot different. After running the numbers through Morningstar.com, you find that your return including dividends jumps to almost 34% during the same period. That’s good wealth creation, and the dividend reinvestment makes a very significant difference.

One of the best things stock market investors can do in a slow growth environment is to find good blue chip companies that pay dividends, and look to accumulate positions when they are down. I think it pretty reasonable to assume that capital gains from the stock market are going to be very modest (if they exist at all) over the next couple of years. With interest rates so low, dividend income is attractive and dividend reinvestment is one of the best ways to increase your wealth.

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